Inter-TSO Compensation Mechanism (ITC)

In section 3.1.2.4, we have argued that the determination of entry-exit charges based on administrative (e.g. national) borders may impair cost-reflectiveness and create barriers for cross-border trading. In this context, we have furthermore analysed the potential application of an inter-TSO compensation mechanism (ITC), which has already been applied in the European power sector since 2002 and which has also been suggested as a potential solu-tion for the gas market.

The idea of an ITC mechanism would solve or at least mitigate this problem, whilst still allow-ing for the co-existence of (different) national tariff regimes. In order to achieve these objec-tives, this concept is effectively based on the simultaneous application of three different ba-sic measures as follows (see also Figure 23):

• Reduction or even abolition of explicit cross-border tariffs;

• Introduction of a financial compensation scheme (ITC) between several TSOs that compensates each of them for the costs of enabling cross-border flows through its network; and

• Harmonisation of the split between entry- and exit-charges in national tariff systems with the principles for the distribution of costs under the ITC.

Facilitate equal

Figure 23: Interaction and impact of measures related to regulation and investments

The first element would obviously improve the scope for the (efficient) use of available ca-pacities and promote convergence of wholesale prices by reducing the specific costs of cross-border transactions. Conversely, the second element is aimed at ensuring that each TSO or national system is fairly remunerated for the costs of providing capacity for cross-border flows. This measure effectively provides for an instrument of joint financing of invest-ments with a regional scope (see also section 5.3 below) and should therefore help to en-sure the realisation of investments that are required to expand cross-border capacity. Since the corresponding costs have to be incorporated into domestic tariffs, this measure implicitly results in locational signals as it will cause national transmission tariffs to vary.

Depending on the principles for the distribution of costs on a regional scale, individual coun-tries may experience significant net costs or revenues, which will, amongst others, depend on the (relative) role of injections into or offtakes from the grid in each country. To ensure a level playing field between different groups of market participants, such as producers, im-porters, users of storage, exporters and suppliers to final end users, these measures finally should be supplemented by adjustments to the ratio between entry- and exit charges in dif-ferent countries. Provided that these preconditions are met, the three measures listed above would finally also facilitate the equal treatment of domestic and cross-border flows under an entry-exit regime, even in a system with a significant share of cross-border flows.

This discussion already indicates that the development and introduction of a functioning ITC would require considerable efforts. First and foremost, it would be necessary to develop and agree on the principles for determining and distributing the costs related to cross-border flows. The complexity of this task has been clearly illustrated by the difficulties in deciding on a commonly agreed permanent mechanism in the European electricity sector where a similar model has already been applied for more than five years. Taking into account the much higher share of cross-border flows (and the average transport distance) in the European gas market, the development of a suitable methodology obviously represents an important

condition that should be addressed at an initial stage. Especially if capacity was expanded to enhance security of supply, it would also need to be decided to which extent a correspond-ing system should be based on the capacity becorrespond-ing made available, contracted and/or actu-ally used in each country.

For similar reasons, it is likely that the application of a comprehensive ITC mechanism may result in significant changes of the costs to be recovered under entry-exit charges in certain countries. Besides political opposition in those cases where transmission costs would be in-creasing, such changes may have distorting effects on wholesale market prices during a transitional phase. In addition, fundamental variations in the relative share of transport and wholesale prices may be problematic where historic long-term contracts with fixed tariffs for transport and energy exist. Even in the absence of a regional tariff scheme,⁸³ and partially in contrast to the electricity market, it would be necessary to differentiate the allocation of the resulting payments through the ITC to entry and exit charges in a harmonised way, such as to ensure that both entry and exit charges reflect the desired locational signals.

If cross-border capacities in the region were at least partially allocated by auctions, another aspect to be studied concerns the treatment of auction revenues, in order to avoid a situation where individual TSOs may be remunerated twice for the same capacity, i.e. once through the ITC and once through congestion rents. This would be particularly relevant where the re-sulting revenues are significant in comparison with the payments to be made and the corre-sponding variations in entry and exit charges in different countries, since the positive effects of the ITC in the form of providing locational signals may otherwise be weakened or distorted by the difference in wholesale market prices.

Last but not least, implementation of an ITC would require the development of a suitable contractual and regulatory framework to enable the realisation of the desired financial flows.

This would obviously require relevant agreements at a regional level to be concluded be-tween the TSOs concerned, although at least the consent of the individual regulators in the region would also be needed. In some cases, it may also be necessary to adjust the legal framework in individual countries to allow for corresponding payments to be made to or re-ceived from other countries.

In summary, we believe that significant work still needs to be done before a final decision on the introduction of an ITC mechanism in one or more regions, or even on a European scale,

83 Such as the ‘Regional Entry-Exit Tariff System’ (REETS) that has been studied in the Regional Initiative South-South East

can be taken. Due to the complexity of the task, it furthermore seems beneficial to initially restrict the efforts to a limited region, which should combine systems with varying shares of cross-border flows and, preferably, also be supplied from multiple sources, in order to test the robustness of the methodology developed against variations in regional flows. These considerations suggest that the corresponding issues would best be treated at regional level, for instance in one or more of the Regional Initiatives, potentially building upon the progress already made in the RI South-South West. Conversely, we believe that it would be prema-ture to take any definitive decisions at a European level at this stage.